In Part 1, we provided an introduction to "Blockchain," the distributed ledger technology behind Bitcoin. In Part 2, we discuss some of the business and legal obstacles standing in the way of widespread acceptance of this technology.

As recently highlighted in a Financial Times article, key aspects of distributed ledger technology present some of the biggest hurdles to overcome. Blockchains are trusted because they offer accountability and transparency, but those features raise questions regarding privacy, scalability, and legal regulation.

Privacy

The public nature of Blockchain—where every node has a copy and all transactions can be seen—provides confirmation that prior transactions have not been altered. However, it also means that any private personal or financial information that is required for a transaction becomes public information, raising significant privacy concerns, especially for financial institutions and healthcare companies.

To address these concerns, companies are considering the development of private Blockchain networks where all users agree to confidentiality and use restrictions. Alternatively, sensitive data can be encrypted and held by a trusted third party, leaving enough data to verify the transaction but not enough to recreate the content. Unfortunately, these solutions require human intervention and limit the auditability of the Blockchain. Technology companies continue to work on this problem, but privacy remains a major stumbling block.

Scalability

In a Blockchain, each transaction is added to the prior transactions creating the potential for “Blockchain Bloat.” The longer the chains become, the longer it takes for nodes to download the Blockchain, the more computing power is required, and the longer it takes to verify a transaction.

Two methods being explored to address these issues are “pruning” and simplified payment verification. Blockchain pruning allows users to keep only a predetermined number of transactions on their computers to validate transactions. However, this only works if there is another means for verifying prior transactions. Under the simplified payment verification method, like the protection of private information, only parts of the Blockchain are downloaded, and calculations are performed to confirm the rest of the chain. As noted above, these methods impact auditability and may limit the applicability of the technology.

Legal Concerns

In addition to these structural/technology issues, legal concerns arise when you take humans out of the transaction process. For example, this payment methodology has been the basis for illicit transactions with regard to illegal drug distribution. If there is a programming error or the outcome of the transaction wasn’t what the parties intended (e.g. the mistaken “additional zero (0)” problem), how is the Blockchain corrected or terminated to prevent compounded errors? If nodes are located in many different jurisdictions, what law(s) apply to the transactions? Finally, what happens if a court orders data from the Blockchain to be separately held or removed?

These are all issues being considered by the industry groups we highlighted in Part 1. However, ultimately, once the structural and technology issues are resolved, lawyers and regulators may face difficult questions regarding adoption of the technology.

We will continue to follow the development of this technology and report on its impact on commercial and technology transactions in this blog.